Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Huali Industrial Group Company Limited (SZSE:300979) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Huali Industrial Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Huali Industrial Group had CN¥546.5m of debt in March 2024, down from CN¥1.17b, one year before. But on the other hand it also has CN¥6.80b in cash, leading to a CN¥6.25b net cash position.
How Strong Is Huali Industrial Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Huali Industrial Group had liabilities of CN¥3.86b due within 12 months and liabilities of CN¥179.7m due beyond that. Offsetting this, it had CN¥6.80b in cash and CN¥2.91b in receivables that were due within 12 months. So it actually has CN¥5.66b more liquid assets than total liabilities.
This short term liquidity is a sign that Huali Industrial Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Huali Industrial Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Huali Industrial Group grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Huali Industrial Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Huali Industrial Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Huali Industrial Group produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Huali Industrial Group has net cash of CN¥6.25b, as well as more liquid assets than liabilities. And it also grew its EBIT by 14% over the last year. So we don't think Huali Industrial Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Huali Industrial Group that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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